6. General Equilibrium and Economic Efficiency

Question 1

Partial Equilibrium Analysis

Answer 1

The focus on how demand and supply were affected by the price of the particular good
- How equilibrium is then affected in that set

Question 2

Interdependency of Markets

Answer 2

Changes in one market will have an effect on prices and quantities in other markets.
- Equilibrium in all markets are simultaneously determined

Question 3

General Equilibrium Analysis

Answer 3

When a market is able to:
- Limit the discussion to the behaviour of competitive markets
- focus on ‘pure exchange’ (consumption)

Question 4

The Edgeworth Box

Answer 4

Demonstrates the 1st and 2nd theorems of welfare economics
- Represents the split of goods
- Learn the graph and the explanation of the graph
- See the shift when trade is introduced to the mix

Question 5

Pareto Efficient Allocation

Answer 5

• Indifference curves must be tangent in the interior of the box
• If they cross, there must be some mutually advantageous trade = CANT BE PARETO EFFICIENT
  Origins of the box are Pareto efficient too.

Question 6

Contract Curve

Answer 6

The set of all Pareto efficient points that satisfy: MRS^A = MRS^B condition e.g.
1. Economic Efficiency = perfect price discriminating monopolist
2. Economic Inefficiency = a monopolist with uniform pricing

Question 7

First Theorem of Welfare Economics (Invisible Hand Theorem)

Answer 7

If everyone trades in a perfectly competitive market, all possible gains from exchange will be exhausted and resulting equilibrium allocation will be Pareto optimal.

Question 8

Implications of the 1st Welfare..

Answer 8

• Competitive market structure has right properties to achieving PEA
• Competitive markets economise on info from 1 agent: they only need to know the prices
• Competitive markets as a way to achieve resource allocation.

Question 9

Second Theorem of Welfare Economics

Answer 9

If individual preferences are convex, allocation on the contract curve can be sustained as a competitive market.

Question 10

Implications of Second…

Answer 10

• Equitable outcome is theoretically achieved by reallocating resources within society
• State can transfer purchasing power in a ‘just’ way
• Competitive markets achieve efficient allocation
• Equality in distribution is separable from issues of efficiency

Question 11

Achieving Redistribution in Second

Answer 11

• Distortionary Tax = taxing something that is sold to change agents’ behaviour and therefore value of endowment
• Distortionary Tax associated with efficiency loss
• Price should reflect scarcity and not manipulated for equality reasons

Question 12

Categories of Market Failure

Answer 12

1. Market Power (imperfect competition)
2. Incomplete information
3. Externalities (consumption or production)
4. Public goods